Less Discussed Reasons Why Trump, Congress, and DCF Mean A Sideways-to-Upward Stock Market
Valens Research would like to share with you the Litman Letter for November 2016, which discusses how the surprise US election results earlier this month could spell continued upside potential for the market, even after the post-election run.
Specifically, a combination of an “all red” House and Senate and a Donald Trump presidency spells a lot of reasons for optimism for the market. Everything from infrastructure to regulation to, most importantly but least spoken about so far for valuation purposes, taxes are areas where an all Republican Washington could legislate stiff tailwinds for the factors that drive basic DCF models, and therefore the overall market.
There is still substantial uncertainty about what will actually happen with many policy decisions. Congress could resist deficit spending to finance infrastructure, tough talk on trade could stifle some highly geographically diversified sectors, or Trump’s actions could create some geopolitical instability, all of which could change the story down the road. However, assuming many of the key topics that are being discussed for his first 100 days come to fruition, US corporations and US investors are likely to benefit, especially relative to the policies that were expected for 2017 and beyond before the polls closed on November 8th.
In the file linked below, we discuss how the policies being proposed by the incoming administration could impact all three key drivers to a DCF model of the US market as a whole: profitability (ROA), growth (Asset Growth) and the cost of capital. And most importantly - it discusses how this spells a recipe for market upside and a "buy-the-dips" mindset.
We hope you find the article interesting.
Valens' equity and credit research relies on a bedrock of deep fundamental forensic analysis with a coverage of over 4,000 equities and all major corporate credit. That means “cross-capital” equities and credit research are not siloed, but instead are fundamentally aggregated and compared with orthogonal data points.
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Professor Joel Litman
Chief Investment Strategist
joel.litman@valens
-
securities.com
The Litman Letter
November 2016
Less Discussed Reasons Why Trump, Congress, and
DCF Mean A Sideways
-
to
-
Upward Stock Market
•
An all
-
red House and Senate
—
and cabinet
—
may be as
big news for the stock markets as Trump himself, as seen
through a
Discounted Cash Flow model (DCF)
•
Republican policies for continued low capital gains and
dividend tax
rates will
keep the cost of capital down,
increasing earnings multiple
potential; distinctly
opposite
of what had been expected under a Hillary administration
with the previously anticipated Democrat
-
blue Senate
•
Continued focus on the issue of double
-
taxation has favor,
and Republican
-
red policies for lower corporate taxes
mean overall higher operating cash flows in the DCF
•
Increased infrastructure spending may increase business
growth,
but may
be offset by lower growth from
protectionist policies and tougher international trade
•
Barring wilder scenarios such as
Trump
-
driven
military
action, the net of these policies suggest a sideways
-
to
-
upward market with a BTD
—
buy
the
dips
—
mindset
Valens Securities
110 Cambridge St.
Cambridge, Massachusetts 02141
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2601
Why
Trump,
Congress,
and
DCF
Mean
A
Sideways
-
to
-
Upward
Stock
Market
Seeing
Red
All
Over
One
of
the
benefits
of
the
checks
and
balances
of
the
US
Government
is
that
the
President
needs
the
agreement
of
the
House
and
the
Senate
to
enact
many
major
policy
changes
.
The
Trump
headlines
overwhelmed
what
might
otherwise
also
have
been
a
major
headline
:
that
the
House
and
the
Senate
are
now
both
red,
Republican
.
Recent
Trump
appointees
in
Gingrich,
Priebus,
and
other
considerations
solidify
that
the
White
House
will
be
decidedly
red
as
well,
if
there
had
been
any
doubt
beforehand
.
Barring
any
wild
cards
such
as
Trump
-
driven
military
action,
or
dare
we
say
war,
the
stock
market’s
underlying
discounted
cash
flow
model,
DCF,
suggests
a
sideways
-
to
-
upward
stock
market
based
on
known
Republican
policies
driving
taxes
and
spending
.
Drivers
of
DCF
We
subscribe
wholeheartedly
to
the
presumption
that
over
time,
stock
market
valuations
center
on
discounted
cash
flows
.
Market
valuations
represent
the
present
value
of
the
cash
flows
that
the
underlying
companies
will
likely
deliver
to
investors
.
When
thinking
about
this
aggregate
DCF
model,
or
any
DCF
model,
it
helps
to
break
it
down
into
three
levers
:
return
on
assets,
asset
growth,
and
the
cost
of
capital
to
investors
.
We
separate
free
cash
flows
into
drivers
of
returns
and
asset
growth
because
of
the
incredible
difficulty
in
forecasting
or
benchmarking
free
cash
flow
by
itself
.
If
we
know
returns
and
growth
rates,
we
of
course
can
calculate
free
cash
flows
as
well
.
The
benefit
is
that
return
on
assets
is
benchmarkable
,
debatable,
trend
-
analyzable,
and
far
more
easily
forecastable
.
Asset
growth
is
also
easily
comparable
across
peers
and
across
time
.
This
is
not
so
easy
with
free
cash
flow
metrics,
as
one
can’t
discern
whether
free
cash
flows
move
because
of
changes
in
profitability
or
changes
in
investment
.
Our
past
research
and
articles
on
“good
free
cash
flow
versus
bad
free
cash
flow”
highlight
this
conundrum
of
thinking
about
free
cash
flows
without
separating
it
first
into
returns
and
growth
.
The Litman Letter
November 2016
Page
2
The
D
in
DCF
is
for
the
discount
rate,
also
known
as
the
cost
of
capital,
or
the
investors’
required
rate
of
return
.
Two
of
the
most
overlooked
drivers
of
discount
rate
levels
are
the
killer
combination
of
inflation
and
taxes
—
especially
when
taxes
are
non
-
inflation
-
adjusted
.
Our
research
on
this
topic
adopts
and
builds
on
the
seminal
research
of
Bart
Madden
.
Impact
of
Red
Policies
and
Inflation
on
the
Cost
of
Capital
We
can’t
say
enough
how
impactful
Madden’s
research
has
been
on
our
thinking
around
valuations
.
One
area
that
he
focused
us
on
20
years
ago
was
the
research
showing
the
impact
of
investor
taxes
on
cost
of
capital
.
If
capital
gains
and
dividend
taxes
go
up,
the
investor’s
take
-
home
cash
flow
falls
.
With
no
change
in
corporate
returns
or
growth
rates,
valuations
have
to
fall,
naturally
.
In
a
DCF,
if
free
cash
flows
remain
the
same,
and
less
of
those
free
cash
flows
reach
the
investor
because
of
taxation
at
the
investor
level
—
prices
fall
despite
consistent
corporate
performance
.
Please
note
our
past
research
and
articles
on
the
impact
of
investor
taxes
and
market
earnings
multiples
over
the
last
100
or
so
years
.
The
relationship
between
investor
taxes
and
P/E
multiples
is
nearly
year
-
over
-
year
lock
step
.
Higher
investor
taxes
create
lower
valuations
as
aggregate
multiples
show
.
That’s
because
higher
investor
taxes
increase
the
cost
of
capital
.
There
is
little
debate
that
Hillary
Clinton
intended
to
bring
back
the
era
of
higher
taxes
on
investors
.
US
investors
have
previously
enjoyed
a
15
%
capital
gains
and
dividends
tax
rate,
which
were
brought
about
by
tax
policies
and
benefits
over
the
Reagan,
Bush,
and
Bill
Clinton
presidencies
.
Over
the
last
several
years,
these
have
risen
to
24
%
.
However,
that
amount
is
still
far
lower
than
the
Federal
39
%
,
plus
medicare
override
of
3
.
9
%
for
higher
earners,
plus
state
taxes
on
top
of
that
—
all
on
ordinary
income
.
One
caveat
is
that
a
low
-
tax,
high
deficit,
increased
US
debt
world
could
create
an
inflationary
environment
.
Because
investor
taxes
are
not
inflation
-
adjusted,
effective
tax
rates
on
stocks
actually
go
up
with
inflation
.
That
would
bring
multiples
down
.
Overall,
an
all
-
red
congress
and
White
House
suggest
that
taxes
on
investor
returns
stay
at
historically
lower
levels,
albeit
not
the
lowest
.
That’s
a
green
light
for
stock
markets
.
The Litman Letter
November 2016
Page
3
Impact
of
Red
Policies
on
the
Returns
Driver
of
the
Market
DCF
In
an
all
-
red
administration,
the
potential
for
lower
corporate
taxes
is
higher
.
That
drives
corporate
returns
up
.
Less
taxes
to
pay
the
government
means
more
cash
flow
from
operations
.
That
means
higher
corporate
return
on
assets
than
otherwise
.
It
remains
to
be
seen
what
other
policies
may
take
effect
that
impact
corporate
returns,
however
they
have
been
incredibly
high
and
steady
for
the
last
several
years
.
Note
that
to
get
to
this
kind
of
aggregate
chart
of
corporate
returns,
we
need
to
first
handle
all
the
distortions
and
inconsistencies
inherent
in
financial
reporting
due
to
Generally
Accepted
Accounting
Principles
.
For
this
reason,
this
aggregate
chart
shows
returns
that
have
been
adjusted
for
UAFRS,
Uniform
Adjusted
Financial
Reporting
Standards
.
Under
UAFRS,
we
restate
earnings,
assets,
and
debt
by
removing
differences
between
companies
and
over
time,
that
occur
from
inconsistent
and
wildly
varying
financial
reporting
requirements
.
Impact
of
Red
Policies
on
the
Asset
Growth
Driver
of
DCF
On
the
corporate
growth
side,
it’s
not
so
certain
what
could
happen
.
On
one
hand,
businesses
may
find
new
government
resources
or
unlocked
resources
for
infrastructure
spending
.
Roads,
bridges,
and
supposedly
walls,
could
all
spur
growth
in
certain
obvious
areas
of
the
private
sector
.
This
assumes
that
the
threat
of
potential
budget
deficits
doesn’t
keep
those
resources
from
being
spent
.
Just
because
Trump
wants
infrastructure
spending
doesn't
mean
he's
going
to
get
it
.
Obama
wanted
that
too
.
The
impediment
is
that
deficit
reduction
is
also
a
red
policy,
and
the
Republican
congress
may
not
allow
that
spending
boost
.
The Litman Letter
November 2016
Page
4
8%
6%
8%
8%
8%
8%
6%
8%
9%
10%
10%
11%
10%
9%
11%
11%
11%
11%
11%
10%
9%
11%
12%
0%
5%
10%
15%
20%
25%
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016E
2017E
Mkt
Imp
ROA'
Data Date: As of 11
-
Nov
-
2016
Source: Capital IQ, Valens Securities Analysis
U.S. Aggregate Return
on Assets
2 ,424
U.S. companies (non
-
financial)
UAFRS
-
based ROA
Also,
closed
international
trading
policies
tend
to
reduce
growth,
and
some
of
the
policies
bandied
about
certainly
sound
growth
-
inhibiting
.
So,
net
-
net
we
may
be
seeing
another
period
of
subdued
growth
levels
by
US
corporates
.
That
said,
current
US
valuations
do
not
embed
historically
high
growth
anyway
.
In
the
low
growth
world
we’ve
had
for
the
last
several
years,
current
market
valuations
certainly
weren’t
pricing
in
a
widespread
spike
in
corporate
growth
with
either
candidate,
Trump
or
Hillary
.
Still,
with
the
high
corporate
ROAs
that
we
see
today,
one
would
hope
that
companies
would
find
places
to
invest
instead
of
continued
share
buybacks
.
We
might
not
see
that
overall
under
a
Republican
dominated
government
.
However,
that
hadn’t
been
priced
-
in
to
market
valuations
previously,
and
if
the
catalysts
discussed
above
create
it,
that
signals
market
upside
.
In
Conclusion
We
make
no
political
statement
on
whether
or
not
Hillary
would
have
been
a
better
President
than
Trump
.
History
has
shown
that
the
supposed
intentions
of
candidates
made
during
the
campaign
can
change
remarkably
once
they
hold
office
.
However,
on
the
drivers
of
the
market’s
DCF
model,
certain
policies
were
made
very
clear,
and
a
fully
Republican
political
landscape
does
suggest
some
certainties
about
valuation
.
All
in
all,
these
more
certain
policies
suggest
a
sideways
to
upside
stock
market
.
The
less
known
policies
are
anyone’s
guess
.
The Litman Letter
November 2016
Page
5
Data Date: As of 11
-
Nov
-
2016
Source: Capital IQ, Valens Securities Analysis
U.S. Aggregate Asset Growth
2 ,424
U.S. companies (non
-
financial)
9%
11%
8%
13%
10%
7%
7%
8%
9%
9%
9%
6%
7%
6%
8%
8%
6%
5%
2%
5%
5%
0%
5%
10%
15%
20%
25%
30%
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016E
5Yr
CAGR
UAFRS
-
based Asset Growth
info@valens
-
securities.com
■
TEL +1 (646) 491
-
2601
■
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-
securities.com
Copyright 2014, Valens Securities.
All Rights Reserved. Please refer to the last page.
The Litman Letter
Joel
Litman
Chief Investment Strategist
joel.litman@valens
-
securities.com
+1 (646) 491 2601
©
2014
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